Many finance news articles published on Wednesday contained headlines or opening sentences along the lines of “Stocks rally on speculation of central bank stimulus.” How the writers of these articles would be able to prove or quantify this speculation is unclear. This is just the kind of naked assertion the financial press makes when there isn’t an obvious cause for a big move in the stock market.
We would argue that the non-headlines represent a tipoff that the fundamentals are askew. When the only justification for higher prices is a currently non-existent plan for central-bank intervention, traders may actually be receiving an important signal. When “the market” doesn’t know why it’s trending higher (or lower), the most reliable forecast is in favor of higher volatility in the short-term.
Stock Market: A Quick Look at Current Divergences
Uncertainty isn’t the best timing indicator, but it is a good measure of trend-strength, which is equally important. We would argue that although stocks have been flat for an extended period of time, the long-term trend is still technically bullish.
Although we haven’t seen any big breaks since January, the more asset classes diverge from normal bullish behavior, the more likely we are to see increased volatility and strong resistance.
As you can see in the chart below, the normal relationship between bonds (blue line) and the yen (gold line) versus stocks (candles) is reversed.
We would normally expect investment-grade bonds like U.S. Treasuries to fall when stocks are rising as capital flows from one asset class to the other. The yen is cheap to borrow, which makes it an ideal funding instrument for stocks. However, when the yen (one of the world’s largest asset classes) rises in value, it tends to weigh on stocks.
If you look closely at the graph, you can see the normal relationship between rising bonds and the yen during the January market decline. Both “safety” assets flattened or declined during the February rally, but they have since continued to move higher as stocks have been rising again. This is a divergence that has worsened since we last pointed it out.
The forecast during market conditions like these is a little bearish, but timing is difficult. The decline in January was preceded by a three-month consolidation, and the drop last August was preceded by a nearly seven-month-long channel.
Although we can’t put a very fine point on when the market is likely to drop, we can do a better job of saying where the market isn’t likely to go. All bullish speculation aside, resistance is extremely difficult to break during an asset divergence like this. Bullish days may look attractive, but upside is extremely limited.
At the risk of sounding glib, the fact that the stock market is rising on “central-bank speculation” and that the “most-shorted” stocks are leading the way isn’t a good sign. The harsh reality is that this is the kind of day/week when most long positions have too limited upside to be very attractive even though bearish positions are struggling.
InvestorPlace advisors John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.